For hundreds of years, people starting businesses have formed corporations. They’ve done this in order to shield their private property from the obligations of their businesses. But is simply creating a corporation or a limited liability company enough to accomplish this? No.
Both forms of ownership attempt to insulate the owners’ personal assets from the business’s liabilities. If a corporation cannot pay its debts, the owners stand to lose the amounts of their investments but not their personal holdings. However, neither the corporation nor the LLC is a perfect shield against personal liability. There are several factors that should be considered regarding these forms of ownership.
In some states, members of certain professions cannot incorporate or form LLC’s. These may include physicians, attorneys, architects, and accountants, among others. In such situations, the corporate liability shield is simply not available.
Corporations and LLC’s are required to perform certain activities. Corporations must create by-laws; LLC’s must create operating agreements. Both documents explain in detail how the organization will be run. They obligate the organization to do things such as hold formal stockholder meetings, conduct elections of officers, and so on. A corporation must also file tax returns. All of these activities cost time and money.
Corporations and LLC’s are liable for their debts, performance of contracts, and their torts. Even though the owners (or “members,” as the individuals comprising an LLC are called) have limited individual liability, the organizations have no such limitation. It must obtain funding for potential liabilities.
In extreme cases, courts may discard the liability protections entirely. Individual stockholders or members may then face legal actions. These tend to be instances involving fraud or outrageous disregard of the public good. For example, the stockholders of a corporation that performs dangerous activities and that deliberately fails to buy liability insurance could lose their liability protection.
Individual directors and officers of a corporation can be the targets of stockholder lawsuits. This could happen if the stockholders believe that their investments have suffered because the corporation has been mismanaged.
Organizations can finance many of these liabilities with appropriate insurance in sufficient amounts. General liability insurance covers responsibility for injuries and damages to third parties. Employment practices liability insurance covers the organization’s legal liability for wrongful acts committed against current or prospective employees. Directors and officers insurance protects against stockholder lawsuits.
Corporations and LLC’s need all of these, and in large amounts. Business owners should discuss with a professional insurance agent and an attorney the limits of insurance that are appropriate for their situations. In addition to general liability policies, all businesses should purchase umbrella policies for adequate protection. Small businesses need umbrella policies that provide limits of at least $5 million. Medium to larger sized businesses should consult with a risk manager who can evaluate their exposures and suggest appropriate limits.
The corporate and LLC forms of business ownership provide many advantages to the owners. In many cases, they will protect owners’ personal assets. However, that protection is not absolute. Before you form a corporation or LLC, consult with a qualified attorney and with a professional insurance agent who can provide advice on the types of insurance coverage needed.
Contact G.R. Reid Insurance Services to arrange for a consultation.